Surprise as inflation hits 2%

Monday 12 August 2002 23:00 BST

INFLATION figures produced another surprise today after the underlying rate rose by more than expected to 2%. Analysts had been expecting a more modest 0.3% increase in July's figure from the record low seen the previous month of 1.5%.

The underlying figure, which strips out mortgage interest payments, is 0.5% short of Chancellor Gordon Brown's 2.5% target.

The Office for National Statistics said the inflation rise largely stemmed from one-off base effects, with the fall in seasonal food prices much less pronounced than a year ago.

It added: 'Prices of fresh fruit and vegetables decreased overall in July by less than last year when the recoveries in supplies led to substantial falls in prices.'

Clothing, footwear and furniture prices also contributed to the rise, with the impact of summer sales much less than last year.

The headline rate, which includes mortgage interest payments, also rose 0.5% to 1.5% - the highest level since last October.

The underlying rate was last higher in April when the figure stood at 2.3%. Since then, economists have been surprised by a 0.5% fall in May's figure and 0.3% in June.

Today's data from the ONS casts doubt over whether the Bank of England will now have room to sanction another interest rate cut to lift the faltering economic recovery.

At the same time, the bank is facing increasing pressure to cut interest rates following a sharp slowdown in the High Street spending boom that has kept the economy afloat for the past year.

Calls for a quarter-point cut when the Bank's Monetary Policy Committee meets early next month came from both business and union leaders, after figures from the British Retail Consortium (BRC) revealed spending growth dipped for the second month in succession in July.

The Bank's base rate has been stuck at its current 38-year low of 4% for nine months. Until the recent global collapse in stock markets, most economists had been betting that the next move would be upwards. However, the consumer slowdown and a sudden fall in manufacturing output in June mean many now believe the economy needs lower borrowing rates to give it a boost.

BRC director-general Bill Moyes said: 'The case for the Bank of England to stimulate demand by a slight reduction in the base rate is appearing stronger.'

TUC General Secretary John Monks said the current historically low level of inflation gave the Bank plenty of room to manoeuvre. 'The Bank should cut rates by a quarter percentage point,' he said.

The BRC figures showed High Street sales grew by 3.8% in July, down from 4% in June and 6.1% a year ago.

British rates are still much higher than the 1.75% rate in America. Tonight the US central bank, the Federal Reserve, meets to discuss the level of interest rates. Although the markets are not expecting a cut, they are hoping for a signal of lower rates in the near future.